Saturday, May 22, 2010

“We will not allow that the euro zone problems and an excessive rise in the franc to lead to deflation in Switzerland. That defines our policy with regards to the exchange rate. The bank will act in a decisive manner if needed.”

There has been a lot of speculation in the past 48 hours on who did what in the FX markets as far as intervention is concerned. The Treasury Department has a “no comment”. The ECB and the SNB have been mum. I will stick my neck out and say it was the Swiss that did it. A two-day chart of Euro/CHF:

The two vertical lines are evidence of market intervention. That is not just short covering. This was a size buyer that did not care if the execution was sloppy. It looks to me like an effort at “shock and awe”. Some thoughts:

-As of 3/31/2010 the SNB had Euro 53b in reserves. They reported that these holdings had a mark to market loss for the Q of CHF3.1b ($2.9b). The NZZ has reported that SNB purchased an additional Euro10b in April. It should therefore come as no surprise that the SNB bought more Euros and sold more CHF in the past day and a half.

-The graph shows that the FX rate was just a tad above 1.40 for a few days prior to the blow up. I suspect that this was the SNB providing support to the market on an ongoing basis. These are stabilizing efforts. It is a “containment" policy it is not “shock and awe”.

-The night of the Merkel “no trading” rules the Euro/$ hit a new low. Logically there would have been pressure on the Euro/CHF. But it held. Here I suspect that “resting orders” were in place to continue the containment.

-Watching the market on Wednesday I concluded that there were three separate rounds of intervention in the E/CHF. Each resulted in a spike in the rate and then a resumption of trading. The end result was a 2% backup. That is a big move in this cross. This activity all took place during peak European and NY FX markets. At that time there are thousands of players. The market is deep and big numbers can get done. The intervention required to move the market this much would have to be more than Euro 5b.

-The E/CHF rate was fairly quite today. Until 2 pm. Then another demand driven gap upward. I saw no reason in the other markets for this gap. If a “real” market player wanted/needed to buy size E/CHF they would not have done it a half-hour before the futures close. This stinks of “Shock and Awe”.

-The E/CHF market is a derivative of the $/Euro and $/CHF. To unwind demand for E/CHF one could buy $/CHF and sell $/Euro. The crosses have to match out with the cash prices. During European trading the CHF crosses all have big floats. But in late NY markets they do not. So if a big buyer of E/CHF appears it will result in a seller of $/Euro. (Demand for Euro). This explains why the E/$ rate went ballistic this afternoon.

But why? I am not sure. There could be many motives at play.

The SNB had every reason to intervene. They said they would and they did. They did what they have been doing for months. But in my opinion the shock and awe of the last few days is very atypical of the SNB. The question is, “Were they asked to change their strategy?”

The ECB has shown their hand. They have not actively intervened during European markets. If they had we would know about it. The ECB would have announced their efforts publicly. The job of the ECB is to manage a downward path for the Euro. They are well aware of the collateral damage to the other markets a weak Euro could cause. They need a weaker Euro, but they can’t afford a collapse of the bond/equity market. So Trichet calls up Hillebrand and says,

JCT: “Do us a favor. Make a very big bid in the E/CHF. This will help us out against the dollar, pound and Yen.” Hillebrand could have said,

PH: “Okay, we will step up to the plate over the next few days. First in Europe and the next day we will attack the weak Chicago market. But here is the deal, The ECB has to cover our losses. We'll roll them for you at Libor +2.”

JCT: “We’ll cover the losses. It doesn’t matter any more. Go out and kill some wolves for us.” (Heard muttering in the background: “Cheap Swiss”)

There is a Fed NY role in this. All Central Banks talk to each other (they also call big market makers). For me it is not possible for the SNB to have done anything in the NY trading hours without the knowledge, advice and consent of the NY Fed. This scares me a bit. We are in very nervous times. There has been no public statement of any intervention. So this is the stealth variety. I am not suggesting that the NYFed did anything today or yesterday. But if the SNB did, they had a chat:

SNB: “We are thinking of calling JPM in NY and putting in a market order to buy up to 3b E/CHF. What do you think?:

NYF: “Swell idea. The S&P is in the dumper. We are getting calls from all over. If you bid for size it will roll into the dollar market and bid up the Euro across the board. Is that what you want?”

SNB: “We are after the wolves today.”

NYF: “Suits us, Have at em. But one suggestion, do it at 2 pm. A few weeks ago a size order in Chicago at 2:30 caused a 10% micro burst in equities. Maybe you can do that again today. Wouldn’t it be a hoot if we actually killed a whole pack of wolves!

I don’t have a pipeline into the NYFed, the ECB or the SNB. This "take" on the market action in the past few days just lines up with the facts. If I am right, there are a few conclusions.

-The monetary authorities are very worried and are willing to use aggressive strategies to calm instability.

-Using the SNB as a single source of global currency intervention will not work for long. The ECB and the Fed are playing weak hands. They know if they intervene and fail it is lights out. So their active/visible participation is a last resort option.

-Another chapter in this story will be written soon. Possibly this weekend.